Trade finance is virtually unknown in the Pacific. Vast distances, small economies, a preference to do business using cash, and traditional banking methods have all contributed to a trade finance shortage in the region. This means that local businesses don’t get the support they need to conduct overseas trade.
Attitudes are gradually changing, though, both among businesses and banks.
We recently met with several local companies in Samoa, where the National Bank of Samoa and Samoa Commercial Bank in June joined the ADB Trade Finance Program (TFP). One of the businesses was Samoa Stationary and Books, set up in 2008 but which these days is a large retail store, which imports furniture and household items for sale to the domestic consumer market. Right now, to bring in goods, the firm must apply to its bank for a loan, and then use the proceeds to pay the exporter upfront, before goods have even left the shelves of the exporter’s warehouse.
This is disadvantageous in many ways.
Firstly, the importer in Samoa must take out a loan in local currency at a high interest rate, usually above 10%. Secondly it would normally have to tie up collateral, such as property, against that loan. Thirdly, the business risks huge cash flow strain as it makes the payment upfront. In the case of Samoa, it could be 2 to 3 months before the goods arrive. Fourth, there is still the risk that the exporter will not make good on its delivery of purchased items, in which case the local business loses all. Finally, consumers also suffer, as the high costs of finance is passed on. In Samoa, the prices of household items are double those found in many other countries in the world.
As a solution, TFP is now working with the local banks in Samoa to help them introduce products such as letters of credit, or LCs. These allow an importer to pay after it has taken possession of the goods and they also come with deferred payment periods, which mean the importer gets a credit period. This can allow the importer to sell the goods and then subsequently pay back the exporter from the proceeds of the sales. This frees up much-needed working capital, enabling businesses to scale up. LCs, furthermore, are denominated in the currency that the exporter expects payment in, usually US dollars, which means a much lower interest rate. In Samoa this could be as much as 5 percentage points lower than local currency rates.
When we spoke with Fiti Leung Wai, the CEO of Samoa Stationary and Books in Apia, she responded with great enthusiasm about the possibilities for expanding her business, solving her cash flow problem, and paying less interest.
Unfortunately, though, it is not that easy. LCs are effectively a bank guarantee that a trade payment will be made at a future date by a bank on behalf of its importing client. This is fine as long as the importer’s bank, issuing the LC, is a known counterparty and has a decent credit rating. But what happens when that is not the case, especially in countries like Samoa, far removed from big financial markets? The transaction fails or it must be done in cash.
This then is where the TFP comes into play by backing the Samoan banks by issuing its own guarantees. In other words, if the Samoan bank fails to make the payment, ADB will step in. On average, TFP supports about 2,000 of these transactions per year in the 20 countries in which it operates, and around 80% are for small and medium-sized enterprises.
However, a significant obstacle remains to bridging the trade finance gap in Samoa and elsewhere in the Pacific, which is that business volumes are too low for most global banks to justify doing the work needed to establish a correspondent relationship with local banks there. Moreover, in the new regulatory environment it costs these banks at least $20,000 just to cover the costs of conducting anti-money laundering and know-your-customer due diligence.
Apart from imports, Pacific companies also need access to finance to export goods. In Samoa, Ms. Leung Wai is looking at a new handicraft export business. The TFP’s funded trade product, where ADB lends though banks to local businesses—with ADB assuming the bank risk only—could help. Providing foreign currency loans for trade finance also helps local banks to diversify their funding profiles, expand their treasury expertise, access a currency in which trade payments are made—typically with lower rates of interest—and also pave the way for them to engage with multilaterals and overseas banks.
Over 2016 and 2017, the TFP plans to kick off the same kind of support it has brought to Samoa to the Cook Islands, Fiji, the Marshall Islands, Papua New Guinea, Timor-Leste and Tonga, helping build up both local banks and businesses.